Obama is effectively taxing charities with his plan

Sunday

Mar 29, 2009 at 12:01 AMMar 29, 2009 at 2:40 PM

Obama's plan to limit tax deductions for wealthy people who contribute to charitable donations would lead to less donations overall. That's bad for everybody — except the federal government, of course.

Martin Feldstein

President Obama’s proposal to limit the tax deductibility of charitable contributions would effectively transfer more than $7 billion a year from the nation’s charitable institutions to the federal government.

But the high-income taxpayers affected by the rule change are likely to cut their charitable giving by as much as the increase in their tax bills, which would, ironically, leave their remaining income and personal consumption unchanged.

In effect, the change would be a tax on the charities, reducing their receipts by a dollar for every dollar of extra revenue the government collects.

It is hard to imagine a rationale for taxing schools, hospitals, medical research budgets and arts organizations in this way. I suspect that the administration officials who drafted this proposal did not understand that it would have this perverse effect.

The proposed tax change would apply to married couples with incomes of more than $250,000 and single people with incomes greater than $200,000. Under current law, such couples can deduct the value of their charitable gifts from their taxable income.

A high-income person paying taxes at a 35 percent marginal rate lowers his tax bill by 35 cents for every dollar he contributes to a charitable organization. The net cost to the individual is 65 cents for every dollar received by the charity. A substantial body of economic research shows that, on average, each 10 percent reduction in the cost of giving raises the amount that a person gives by about 10 percent. So, the 35 percent reduction implied by current deductibility rules raises the amount of charitable giving by about 35 percent.

The administration’s plan would limit the deduction for high-income individuals to 28 percent of their gifts, down from 35 percent, even though their incomes would still be taxed at a higher marginal rate.

This raises the cost per dollar of giving 10.8 percent, from 65 cents to 72 cents, which can be expected to reduce the total giving of these donors by about 10 percent.

The congressional Joint Committee on Taxation estimated that in 2007, the charitable deductions of those with incomes over $200,000 reduced government revenue by some $23 billion. A 28 percent limit would have cut the $23 billion by about $6.5 billion; charitable giving would have been reduced by an approximately equal amount.

By 2011, when the Obama administration proposes to start the new tax rule, the projected decrease in giving would surpass $7 billion. With the endowments of charitable institutions sharply reduced by the fall in stock prices, this loss of gifts would make an already bad situation worse. The administration should withdraw this proposal.

Martin Feldstein is an economics professor at Harvard University and president emeritus of the National Bureau of Economic Research.